Saturday, April 15, 2017

Entering the Stock Market

A 20-year chart of the S&P 500 ETF shows the money you invested in 2009 would have more than doubled in value by now in 2017. No CD can do that today.

The CD has no risk today other than failing to keep up with inflation. At the end of five years, the result can be the same buying power as when the CD was purchased.

(The new rate for I Bonds, starting May 1, 2017, was set at 1.96% yesterday. That is 0.8% less than the last six months, $2.76. It has a three month penalty if cashed before five years. That leaves Bank CDs and the stock market to consider.)

The Exchange Traded Fund (ETF) is an invention that reduces risk when investing in the stock market. The S&P 500 ETF averages the results of the 500 companies in the S&P 500 index. The long term average is about 6% per year when dividends are automatically reinvested. That is much higher than 2% for CDs.

Compare CD and S&P 500 ETF
The comparison chart shows the return on savings CDs (only interest at risk on renewal, red line) and S&P 500 ETF shares (with the invested pot and dividends at risk daily, solid green line).

There is no way to accurately predict the price of shares at the time we invest. I set a 10% limit on possible gain or loss. If all goes, as most likely, the 5-year CD will be worth $1,120 (red) at 2.3% currently being offered. The shares of S&P 500 (solid green line) would have a value of $1338 after five years.

However a 10% loss at the start would yield $1,204; a 10% gain would yield $1,472 at the end of five years. If the gain or loss occurred later than the initial investment time, their lines would depart from the most likely (green line) to the dashed lines.

[Cashing an immature CD at four years yields about the same amount as a mature 3-year CD (1.60%, which is near current inflation).]

Time is now needed to recover from a decline in share value. In this example the value of shares at two years will equal the initial value of $1,000 with a 10% loss on entering the market. At three years the shares will equal the value of the 5-year CD if cashed at four years. At five years the shares will exceed the value of the CD and of current inflation ($1,204).

Time to recover is a normal part of the stock market. Time manages risk. Therefore we do not invest in the stock market if we need the money sooner than time can bring prices up to expectations. In this example, it takes about three years for the ETF to catch up to the 2.30% 5-year CD given a 10% loss.

There is no cost to the act of buying a CD. Capital One Investing charges $3.95 per buy, any amount of shares or dollars, and $6.95 per sell any amount of shares.

Investing in the stock market is still problematic. My wife has again, as I was typing this, defeated the security system again, for starters.

Also if I have learned anything about the stock market in the past two weeks that I have been working on this; this emotion, fear driven, engine is more apt to proceed as a bear market with lower priced shares than a bull market with higher priced shares. We will see if that bet is true next week.

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